Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / How Climate Shocks Are Rewiring Central Bank Policy
Transcript
- Lucas: Look at the headline CPI number for August: three hundred thirty-four point one. It sounds incremental, but when you strip out food and energy, the core reading is sitting at three hundred thirty-seven point eight. The Fed has been staring at this plateau for months, trying to figure out if it's just sticky services or something deeper. Luna: Right, and usually they blame wage growth or housing costs, but we’re seeing real-world shocks that don’t fit neatly into those buckets. Like the news coming out of France this week about wine production nearing a seventy-year low. Lucas: Exactly. That’s not a cyclical dip; that’s a structural shift in agricultural output driven by extreme heat and water scarcity. When you combine that with the alarm bells ringing from transport companies over fuel prices, you start seeing a pattern where climate events are becoming direct inputs into the inflation equation. Luna: So the question isn't just whether the Fed can tame demand, but whether they can insulate the economy from physical risks that keep pushing costs up regardless of what they do with interest rates. Lucas: That’s the uncomfortable truth. We’re looking at a September twenty-third, two thousand twenty-six market where the ten-year Treasury yield is up nearly four percent over five days to five point twelve percent. Investors are pricing in a future where volatility isn't an anomaly—it's the baseline. Luna: It makes you wonder if the old playbook still works. If crops fail and shipping routes get disrupted by weather, raising rates doesn't make the wheat grow faster or calm the storms. Lucas: Precisely. And yet, the Fed is still using a tool designed for managing aggregate demand to fight costs caused by supply-side fractures. Let’s look at the Core PCE data, which is their preferred gauge. It’s at one hundred thirty point seven, up from one hundred thirty point three four in July. It’s moving, but slowly. Luna: But it’s moving in the wrong direction relative to their two percent target. If agriculture and logistics are getting hammered by climate stress, won't that keep a floor under those prices? Lucas: It absolutely will. Think about the breakeven inflation rate. It’s currently at two point three three percent, slightly down from last week, but that’s still above the Fed’s comfort zone. Markets are telling us they expect inflation to stay persistent, largely because they see these physical constraints. Luna: I’ve been reading some internal memos from major asset managers, and they’re starting to talk about 'climate beta' as a factor in their models. They’re worried that every heatwave or drought event adds a permanent layer of cost to the system. Lucas: That’s a fascinating shift. Usually, we treat weather as noise—a temporary spike in food prices that fades after the harvest. But if the harvest itself is shrinking, it’s not noise anymore. It’s a new trend line. Luna: And it’s not just food. Look at the transport sector headlines. Companies are sounding alarms on fuel prices because their margins are being squeezed by both demand and the cost of adapting to greener, albeit more expensive, logistics networks. Lucas: Let’s bring in the labor market context here, too. The Fed Funds effective rate is holding steady at three point six three percent, but the daily rate has ticked up to three point eight eight. There’s friction in the money markets themselves. Luna: Yeah, and when you add the cost of doing business in a climate-affected world, that friction matters. Small businesses especially are feeling the pinch on insurance and raw materials, which feeds back into wages and prices. Lucas: So we have a scenario where the central bank is tightening financial conditions to cool an economy that is simultaneously being heated by physical realities. It’s a double bind. The VIX is spiking, reflecting that uncertainty. Luna: Do you think the Fed realizes this gap between their tools and the reality of the problem? Or are they just doubling down on the belief that higher rates will eventually force consumption down enough to offset supply shocks? Lucas: I think they’re aware, but they’re trapped by their mandate. They can’t directly address climate risk without stepping outside their legal framework. So they keep trying to crush demand, hoping it’ll stabilize prices, even if it risks a recession that might actually worsen social instability. Luna: It feels like we’re waiting for a paradigm shift in how central banks view risk. Maybe they need to start incorporating climate stress tests into their monetary policy decisions more explicitly. Lucas: That’s a big ask. But consider the Bank of England’s recent move to hold rates unchanged despite global pressure. They’re recognizing that their specific economic structure, including their exposure to European climate impacts, requires a different approach than the Fed’s broad-brush strategy. Luna: Right, so there’s already a decoupling happening. Not just between the US and Europe, but in how different regions are interpreting the relationship between environment and economy. Lucas: And that brings us to the consumer sentiment data. Goldman Sachs noted recently that happiness is down despite a solid economy. People feel the pain of these rising costs acutely, even if the macro numbers look stable on paper. Luna: Because when your grocery bill goes up due to a drought in France, and your shipping costs rise due to fuel prices, it doesn’t matter what the GDP says. Your wallet tells a different story. Lucas: It really does. And that disconnect is dangerous for policy makers. If people lose faith in the currency’s ability to preserve value because of these non-monetary shocks, the Fed loses its most powerful tool: credibility. Luna: So the challenge for the rest of this quarter is watching how the Fed responds to the next set of inflation prints. Will they acknowledge the structural nature of these pressures, or keep pretending they’re just temporary glitches? Lucas: I suspect they’ll say nothing publically, but internally, the models are changing. The interest on reserve balances is at three point nine zero percent, which is keeping liquidity tight. They’re betting that enough pressure will break the back of inflation, even if it means breaking things along the way. Luna: It’s a high-stakes game. And frankly, it feels like the house always wins unless the players realize the table is tilting. Lucas: Speaking of the table, I want to take a brief moment to talk about how this show operates. If walking through the economy with us has made something click, or if you appreciate hearing deep dives like this without ads interrupting the flow, know that listener support is literally what funds making this many of these episodes possible. Luna: We’re a small team, and a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo to keep the lights on and the research sharp. Lucas: It’s not about urgency or perks; it’s just sustaining the work. If you want to help us keep digging into these complex topics, that’s the link. Otherwise, let’s get back to the data. Luna: Agreed. Back to the Fed. One thing I’m curious about is whether other central banks are already adjusting their frameworks more aggressively than the US. Lucas: That’s a great question. The ECB has been hinting at longer-term strategic reviews that include sustainability metrics. Japan, too, is navigating this with its own unique demographic and energy challenges. Luna: It seems like the US is lagging in acknowledging the full scope of the problem. Their focus on short-term employment targets might be blinding them to long-term structural shifts. Lucas: Possibly. But remember, the Fed is also dealing with a political environment that often resists talking about climate change. So they walk a very fine line, focusing on the economic outcomes rather than the environmental causes. Luna: Which is fair, but it leaves a lot of ambiguity for investors who are trying to price in these risks. Ambiguity is expensive. Lucas: Absolutely. And as we head into Q4, with the S&P fifty potentially testing those seven thousand seven hundred levels, that ambiguity could lead to sharp corrections if the underlying assumptions about stable inflation prove wrong. Luna: So, is the answer for businesses to hedge harder against climate risk, or is it for policymakers to finally adapt their tools? Lucas: Ideally both. But until then, we’re stuck watching the Fed try to solve a twenty-first-century problem with twentieth-century instruments. Luna: A fitting metaphor for the current era. Let’s see if they manage to innovate before the next shock hits.